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Difficulty: HardIncome and Substitution Effects on Demand

An economic study tracks a consumer's purchasing adjustment following an increase in the price of Good X. The findings are summarized in the table below:

Economic EffectChange in Quantity Demanded
Substitution Effect−12-12 units
Income Effect+15+15 units

Based on the data provided, what type of good is Good X, and what is the net change in its total quantity demanded?

  1. Good X is a Giffen good, and its total quantity demanded increases by 33 units.Answer
  2. B
    Good X is a standard inferior good (non-Giffen), and its total quantity demanded decreases by 33 units.
  3. C
    Good X is a normal good, and its total quantity demanded increases by 2727 units.
  4. D
    Good X is a normal good, and its total quantity demanded decreases by 1515 units.

Answer

Good X is a Giffen good, and its total quantity demanded increases by 3 units.
The Total Price Effect equation states that Total Effect=Substitution Effect+Income Effect\text{Total Effect} = \text{Substitution Effect} + \text{Income Effect}. With a price increase, the substitution effect always induces a negative change in quantity demanded (−12-12 units). A positive income effect (+15+15 units) following a price increase (which lowers real income) identifies Good X as an inferior good. Because the magnitude of this positive income effect (1515) exceeds the substitution effect (1212), the total quantity demanded increases by +3+3 units. An inferior good whose positive income effect outweighs the negative substitution effect is classified as a Giffen good.

Step-by-Step Solution

1
Calculate Total Price Effect
Total Effect=Substitution Effect+Income Effect=−12+15=+3\text{Total Effect} = \text{Substitution Effect} + \text{Income Effect} = -12 + 15 = +3 units.
The total price effect on quantity demanded is the algebraic sum of the substitution effect and the income effect.
2
Determine Good Classification from Income Effect Direction
Good X is an inferior good.
When the price of a good increases, real income falls. A positive change in quantity demanded (+15+15 units) resulting from reduced real income indicates an inferior good.
3
Evaluate Giffen Good Criteria
Good X is a Giffen good because ∣Income Effect∣>∣Substitution Effect∣|\text{Income Effect}| > |\text{Substitution Effect}|.
When the positive income effect of an inferior good outweighs the negative substitution effect, the total demand curve slopes upward with respect to price, satisfying the definition of a Giffen good.

Key Concept

Decomposition of Price Effect into Substitution and Income Effects for Giffen Goods
Estimated Time:2m 0s
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Topics

Income and Substitution Effects on Demand

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